Corporate Governance: Resources Companies Say "No".

There is more evidence of Australia's resources companies struggling against the corporate governance tide in defiance of what is regarded as acceptable behaviour from everyone else.

Around the world, there is broad agreement on what constitutes good corporate governance. Independent directors overseeing audit, remuneration and nomination functions are a key part. So, too, is an independent auditor uncompromised by other interests. Documented policies dealing with key aspects of executive and director behaviour including risk management and share trading are also expected.

No system of governance is likely to be entirely safe from overtly dishonest people bent on fraud. However, good governance practices might act as a constraint and deterrent on tendencies in that direction.

However, more importantly, governance rules take account of all executives and directors not being of equal quality. Some are better equipped than others to run corporations. Broadly agreed governance practices should help lift standards. They should also create confidence among all stakeholders about the quality of decision making affecting them.

Some commentators and practitioners continue to argue that the governance practices which came in the aftermath of Enron, WorldComm and the IT bubble were a needless overreaction. Those opposed to some of the more highly prescriptive requirements in modern governance standards argue that a one size fits all approach to running companies is inappropriate. They argue that governments do not have an adequate grasp of how flexible businesses have to be and that politicians reacting to populist sentiment are more likely to hobble corporations than enhance them.

The latter view is widely held among Australia's mining companies. An updated study by the Faculty of Business and Law at the University of Newcastle points to Australia's mid sized resources companies eschewing the standards which are being more widely supported by others.

The mining industry displays a shortage of independent directors. It is not unusual for service providers and substantial shareholders to sit on boards. Many so-called non executive directors take an activist role in project development and capital raising.

Having all hands on deck is, in some ways, a commendable use of corporate resources. However, to the extent that directors give up their independence, shareholders lose an important protection. One of the functions of non-executive directors is to oversee executive decision-making and, occasionally, offer alternative counsel. In some circumstances, they will have to act to change an inappropriate business strategy by replacing executives.

If directors are so fully engaged that their objectivity is lost, they will no longer be able to fulfil these important functions.

When confronted with these criticisms, directors at resources firms often respond that they cannot be expected to have the same expensive corporate governance systems that large companies can afford.

The University of Newcastle study looks at the governance standards of 150 similarly sized companies ranked from 250 to 400 by market capitalisation.

This segment of the market contains 51 resources companies or just on one-third of the total companies studied. The researchers judge each company against several widely accepted governance standards and allocate a score of 1 to 5 with a five being for companies with the highest governance standards and a one being for those companies that fall short of meeting most of the criteria.

A similar study has been carried out in each of the past several years. Regrettably, the picture has changed little. Of the 150 companies, 23 were given the lowest ranking. Of these companies with the worst standards of governance, sixteen were from the resources sector.

At the other end of the league ladder, 22 companies were awarded the full five points. Of these, only three were from the resources sector. However, even this might have been too generous. Perilya, the highest ranked resources company, switched its chairman from a nonexecutive to an executive role last year. Again, this removed a layer of shareholder protection at a time when shareholders could have rightly expected to have someone overseeing important strategic decisions.

Two implications of this corporate behaviour are worth considering. Firstly, we have learned in the past year through the bitter experience of the global credit crisis that systemic risks, if they are present, will sooner or later be realized. Being too trusting of those involved, no matter how well intentioned they may be, is simply too risky.

Secondly, directors of resources companies are the custodians of an important industry. Decisions about ownership of mines and the value of resources will have an important impact on national welfare so that the rest of the community needs to be assured that these decisions are being taken in an appropriate manner.

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